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Can This Pumping Systems Company Accelerate Growth?

Although Franklin Systems saw a decrease in net income from 2012 to 2013, there is reason to believe that this trend will not continue.

Franklin Electric(NASDAQ:FELE) sells water and fuel pumping systems around the world. The company sells pumps, motors, controls, pipes, monitoring devices, and more. Founded in 1944, Franklin Electric employs over 4,000 people and currently has a market capitalization of $1.93 billion. For a number of reasons I will elaborate on, I believe Franklin Electric will experience exceptional success in the future.

Recent performanceIn the past, Franklin Electric has achieved phenomenal success. For an astonishing 18 consecutive quarters, the company grew its adjusted EPS. And that isn't just year over year, that is on a sequential basis; such drastic and rapid improvement is very rare to say the least. On top of this, the company has raised its quarterly dividend for 22 years in a row. The dividend currently stands at $0.36 per share, making for a yield of 0.90%. As the chart below illustrates, Franklin Electric has been consistently increasing its net income, with the exception of the past year looking about flat. Way back in 2003, Franklin Electric was simply a motor company with around 2,000 products. Since then, it has evolved into a pumping systems company with 40,000 different products. This growth, in fact, has been so extensive that operating income has increased 760% since 2002.

CompetitionFranklin Electric currently has a few competitors worth addressing. Let's start with Xylem(NYSE:XYL). This company creates all sorts of technologies for water and wastewater applications, including pumps, testing equipment, controls, and more. Overall, the company's operations are remarkably similar to that of Franklin Electric's, just with a sole focus on water. Both Danaher(NYSE:DHR) and Pentair(NYSE:PNR) distribute pumps, valves, and control systems as part of a massive inventory of industrial goods. Franklin Electric competes fiercely with these companies in an attempt to capture profits in the pumping systems market. Let's compare the four companies:

FELE

XYL

PNR

DHR

Revenue

$974.36 million

$3.86 billion

$7.43 billion

$19.34 billion

Levered Free Cash Flow

$32.02 million

$264.25 million

$775.47 million

$2.53 billion

Profit Margin

8.57%

6.11%

8.13%

13.36%

Debt to Equity

0.33

0.56

0.49

0.15

Return on Equity

14.61%

11.06%

9.90%

12.08%

As you can see, Franklin Electric might be the smallest of these four, but it is arguably the most economically effective. Danaher is the only company that seems to beat out Franklin Electric in terms of margins and financial health, but none of these competitors can match Franklin Electric's impressive ROE. If the company maintains or grows current margins and efficiency measures, it should be able to hold down its respective share of the market. It is important to note that different product mixes have a significant effect on the statistics shown here.

Where is Franklin Electric heading?Although the company has accomplished honorable things in the past, I believe the future is just as exciting. One of the reasons for this is the extensive R&D investments. The Water & Fueling RD&E headcount has risen from 61 in 2002 to nearly 150 in 2013. With such a large team of qualified professionals working together, it is inevitable that new product capabilities and improvements will arise continually. In 2013, research and development expenses were at $16.8 million, a 70% increase over the prior year's $9.9 million. These types of investments are truly difference-makers in company operations. These expenses were related to the following activities, just to name a few:

Controls and electric drives for water systems

Centrifugal pumps

Improving energy efficiency in pumping systems

Submersible motor technology

Monitoring and control systems for underground tanks

Improvements to software for automatic tank gauges

As you can see, all of these investments will turn out to make the company more money and provide Franklin Electric's customers with even higher-quality products so they will keep coming back for more. When a company is continually making strides in the right direction and doing all of the small things that need to get done, it will ultimately culminate in successfully reaching some longer-term goals.

It is important to examine whether or not Franklin Electric is outpacing competitors in R&D investments. From an investment point of view, it isn't necessarily about how much is being invested, but rather how much more is being invested as time goes on. The chart below shows the percentage increase in R&D expenses for each company for the past year.

Company

% Increase in R&D for the Last Fiscal Year

FELE

70%

XYL

-2%

PNR

34%

DHR

10%

As you can see, Franklin Electric increased its investments much more dramatically in the past year than competitors. This shows the company has shifted greater focus toward improving existing products and developing new ones. As a result, it's likely we will see more positive changes at Franklin Electric in the near future than we will see from the competition.

Finally, these statistics give me reason to be optimistic about the fueling segment, which currently only makes up 21% of sales:

As you can see, the company has hundreds of thousands of stations both inside and out of the United States. This shows strong geographical diversification and exposure to numerous markets. But the portion of stations with capabilities such as "pressure pumping technology" and "flexible piping" varies largely by both the capability or feature and the location. Based on these percentages, we see areas of growth that Franklin Electric will be able to capitalize on. As the macroeconomic situation continues to improve and economies across the world continue to develop, Franklin Electric can look toward international growth. Many of the stations around the world are lacking "pressure pumping technology," for example. If Franklin Electric can get this percentage from 23% to even 30%, it would mean greater revenues. Some areas could even see improvements within the U.S., such as greater offerings of "flexible piping," which is currently only present at 45% of U.S. stations.

Although gas stations are a significant target market for Franklin Electric, the company sells to other markets as well. For example, the company recently broke into the artificial lift market and began marketing control systems, pumps, and other products that can be used to extract resources from the ground. In 2013, the company tested units in North America, Australia, and Africa. As a result, customer relationships are already developing in these areas, and Franklin Electric also will break into the Chinese market. This should provide at least a few years of increased growth for the company. But overall, the company offers its products to customers in numerous markets, such as OEMs, specialty distributors, oil and utility companies, and more. As the energy market continues to grow as quickly as it has for so many years, Franklin Electric will be able to profit off of these markets.

RisksOverall, the risks that Franklin Electric faces are currently not all that problematic. There are a few concerns the company has, but it has been handling everything well up to this point. One risk the company could face is failed integration of an acquired company. With Franklin Electric relying so heavily on acquisitions, the company needs to be able to successfully add acquired companies' operations to its own while minimizing issues such as duplicate costs, decreased profitability, and so on. Management has done a fantastic job with this so far, and there aren't any indications this will change.

And of course, there are more general risks, the types of things that can't be prevented and are somewhat unpredictable. For example, if the prices of raw materials and other commodities rise, Franklin Electric would experience increased expenses, and margins would fall. Similarly, a lack of investment in the energy sector could be detrimental to Franklin Electric's results, as it would then share with its competitors an even smaller market. This could be caused by macroeconomic, regulatory, political, or other issues.

ConclusionFranklin Electric has enjoyed significant success over the past five years or so, but growth has slowed dramatically in the past year. Because of competitive advantages over rivals (such as profitability, efficiency, and financial health), heavy investments in R&D, and room for improvement from the fueling segment, I believe growth will begin to accelerate once again within the next year or two.